Today's Risky Mortgages: Are They For You?

Rapidly rising home prices have pushed home ownership out of reach of many people, so lenders have created a whole new generation of mortgage loans, ranging from the risky to the downright scary. The Federal Reserve reports that record numbers of people are taking out mortgages with lower initial payments and higher risks, often putting their home and their financial future on the line. Here's a recap of the most popular "new" mortgages, their risks, and when they might be appropriate for you.

Option-Payment Mortgage - the riskiest mortgage out there right now. You choose what to pay every month: the regular principal and interest, interest only, or a minimum required by the lender that may be even less than the interest you owe. The difference gets added on to your loan balance. Danger: you could end up owing more than your home is worth.
This mortgage might be appropriate for you if: you're a financially disciplined person who needs the option of very occasionally making a smaller monthly payment.

Interest Only Mortgage - second only to the Option-Payment Mortgage in riskiness. You pay nothing on the balance of the loan, only the interest, for a period of three to ten years. When the interest-only period expires, your payments will increase dramatically as you begin to pay down the principal. Danger: you may not be able to afford those payments.
This loan might be appropriate for you if: you know you'll be moving out of the house before the interest-only period is up or you're sure you'll be making significantly more money by then.

Low-Doc Mortgage - equally as risky as the interest-only mortgage. You borrow without proving that you qualify for the loan. You may not have to even provide proof of your income. Danger: you may take out a mortgage you can't afford.
This loan might be appropriate for you if: you've just started or are about to start a new business and you're sure you'll be able to make the mortgage payments.

Piggy-Back Mortgage - less risky than the above mortgages. The piggy back loan involves taking out two mortgages: a home-equity loan or line of credit for 20% of the home's value, which you use as a downpayment to avoid having to pay private mortgage insurance, and a primary mortgage for 80% of the home's value. Danger: the value of your home may drop and you may be forced to sell it for less than you owe, since you have no equity as a protective cushion.
This loan might be appropriate for you if: you have a healthy downpayment but not quite enough to avoid private mortgage insurance.

40-year Fixed Mortgage - the least risky of these rather risky mortgages. You have a fixed-rate mortgage but you pay it off over 40 years instead of the traditional 30 years. The payments will be lower, so you qualify for a higher mortgage. Danger: you'll end up paying a lot more for the house, and it will take a very long time to build any equity.
This mortgage might be appropriate for you if: you don't have enough income to qualify for a traditional 30-year mortgage but you'd rather not have the risk of an adjustable interest rate.

One of the concerns about these risky mortgages is that because they make it easier for people to qualify for expensive homes, they may be fueling the rapid rise in housing prices and may end up fueling a rapid decline in homes values.

How To Protect Yourself

With banks willing to loosen their underwriting requirements and issue loans to marginally qualified or unqualified buyers, you'll have to look out for yourself to make sure you don't buy more house than you can realistically afford. Here are three ways to protect yourself:

• Interest rates for mortgages are still incredibly low, so go with a fixed rate mortgage. You'll sleep better.

• Talk to lenders before you begin your home search. Determine how much house you can realistically afford, and look for homes in that price range. Don't be tempted to "buy up," and you may not need to resort to one of these risky loans.

• If you decide to take out an Adjustable Rate Mortgage (ARM), don't go into it blindly. Do the calculations on several possible scenarios. For instance, what if interest rates rise three percentage points? What would your mortgage payment be? Could you reasonably afford the payment? Use an online calculator like those at Bankrate.com to run some numbers and make sure you could live with them.